Tuesday, August 14, 2007

CIBC Expects Write-down of ~$190 Million After Tax

Financial Post, Grant Surridge, 14 August 2007

Canadian Imperial Bank of Commerce confirmed its exposure to the U.S. subprime-mortgage market yesterday -- sending the stock up more than 5% before it settled lower amid a broader market downturn -- but some would have wanted the bank to provide more details.

CIBC announced it would take a writedown of about $290-million ($190-million after tax) on investments in the U.S. mortgage market when it releases third-quarter earnings at the end of this month.

South of the border, financial stocks have taken a beating amid worries over losses on investments linked to mortgages offered to risky borrowers. CIBC shares have lagged those of other Canadian banks for several months while its exposure to subprime-backed assets was subjected to much speculation.

"CIBC has become a target every time there is a problem in the market out there," said Michael Sprung, president of Sprung & Co. Investment Counsel, which owns CIBC shares. "To that extent I think management is really trying to say, we've cleaned up our act and are monitoring everything we can see. And we're no worse off than the next guy."

CIBC said its exposure to holdings connected to the U.S. residential-mortgage market is about US$1.7-billion (excluding that hedged with counterparties), the majority of which is highly rated. The bank estimates less than 60%, or about US$1-billion, of this is linked to subprime mortgages.

The subprime portion works out to less than 0.5% of the company's total assets, said Genuity Capital analyst Mario Mendonca, who described the bank's disclosure as a good move that could have contained more information.

"It would be a good to know what the total exposure is hedged and unhedged," he said. He was also looking for some idea of who CIBC has hedged the investments with.

"Maybe they could tell us these are very highly rated financial institutions," he said.

CIBC is the only Canadian bank to quantify its exposure to the subprime market.

Both Toronto-Dominion Bank and Bank of Nova Scotia said yesterday they have no exposure to investments backed by subprime mortgages, while Bank of Montreal said it has nominal indirect exposure through securitization vehicles, but does not participate directly in subprime lending.

In the second quarter, management at Royal Bank of Canada cited a loss on holdings linked to the U.S. subprime market, but spokesperson Beja Rodeck said as of mid-July, "while we do have some minimal exposure it's not material at all in relation to our total assets and earnings."

CIBC said diluted earnings per share for the quarter ended July 31 should be about $2.30, versus $1.86 for the period a year earlier.

These overall results are ahead of many analyst expectations and the bank attributes the strength to "good revenue, expense and loan loss performance in most business groups, as well as higher than normal gains on securities and credit derivative hedges."

Yesterday's move should clear up some of the questions surrounding CIBC's subprime exposure, Mr. Mendonca said.

"The mistake CIBC made originally was not giving a little more information," he said.
Financial Post, Jonathan Ratner, 13 August 2007

Dundee Securities analyst John Aiken notes that CIBC’s remaining subprime exposure is large yet manageable. And this exposure, coupled with its pre-announced write-down, is well below some of the dire predictions from the Street.

Mr. Aiken believes more write-downs are likely in the future, but if CIBC were to cut its net exposure to zero, the losses would come in at just above $2 per share.

“We view the pre-announcement very positively, even if questions remain about the potential quality of its third quarter earnings,” he said in a note to clients. “Eliminating some of the doubt surrounding CM’s subprime exposure can only be a positive.”

Mr. Aiken raised his rating on CIBC to “market outperform” from “market neutral,” while his price target is $111 per share.

There are two things investors should take note of, says BMO Capital Markets analyst Ian de Verteuil.

The first is that CIBC’s operating results are better than the Street’s estimates.

The second is that despite some subprime exposure, “there was sufficient conservatism, hedges and offsets in other areas of CIBC to allow it to stomach the hit,” he told clients in a note.

Mr. de Verteuil expects CIBC shares will rally $5 to $10 in the short-term, while also anticipating a broader rally for the Canadian bank group on Monday morning.

He recommends Toronto-Dominion Bank, CIBC and Royal Bank of Canada.
CIBC was raised from 'market neutral' to 'market outperform' by analyst John Aiken at Dundee Securities Corp. The 12-month price target is $111.00 per share.
RBC Capital Markets, 13 August 2007

CIBC pre-released Q3/07 earnings to the upside. CIBC expects approximately $2.30 in EPS for Q3/07, well ahead of our estimate of $1.90.

• Expected third quarter results include mark-to-market write-downs, net of gains on related hedges, of approximately $290 million ($190 million after tax) in collateralized debt obligations and residential mortgage backed securities related to the U.S. residential mortgage market. That figure is higher than our July 23 estimate of $50-100 million as the value of assets backed by U.S. sub-prime real estate market weakened further.

• The major earnings offsets came from higher than normal gains on securities and credit derivative hedges, and reversals of litigation and income tax accruals; the magnitude of each item has not been quantified.

• CIBC's unhedged exposure to the U.S. residential mortgage market before write-downs is approximately US$1.7 billion, a larger figure than we anticipated.

• Less than 60% of the US$1.7 billion exposure relates to underlying sub-prime mortgages, while the remainder is mid-prime and higher grade assets. The majority continues to be AAA-rated, and the bank has sub-prime index hedges of approximately US$300 million.

• This announcement is positive in our view, in spite of the exposure to U.S. real estate being larger than we had believed. Since May 22 (the day before the first Canadian bank released Q2/07 results), CIBC's stock is down 17% versus a median decline of 10% for the 5 other banks. The relative underperformance of 7%, which we believe is mostly due to exposure to U.S. sub-prime real estate, represents about $2.3 billion in market capitalization.

• We maintain our Outperform rating. However, we caution that CIBC, like the other Canadian banks, is more likely to trade on news than fundamentals in the near term, and the stock remains susceptible to concerns over the health of financial markets

• CIBC's Q3/07 results will be released on August 30.
The Globe and Mail, John Partridge & Tara Perkins, 13 August 2007

Shares of Canadian Imperial Bank of Commerce leapt more than 4 per cent after the opening bell Monday, dragging competitors stocks' along for the ride, after the bank revealed it expects to report much higher third-quarter profit than Bay Street had expected despite taking a hit on the U.S. subprime mortgage debacle.

In turn, financial sector stocks were the key driver of a rally in the S&P/TSX composite index, which was up 123.09 points to 13,589.37.

In morning trading, CIBC's shares jumped $3.67 to $91.18 on the Toronto Stock Exchange, while its rivals' stocks had gained between 0.46 per cent for Bank of Nova Scotia to 1.54 per cent for Toronto-Dominion Bank.

The rally came after CIBC, apparently seeking to reassure investors amid current market turmoil, disclosed that it has about $1-billion (U.S.) in exposure to the battered U.S. subprime mortgage market but says it still expects third-quarter share profit to come in ahead of analysts' expectations and nearly 24 per cent higher than last year.

In an unusual move two and a half weeks before it is set to disclose its quarterly results on Aug. 30, the bank issued a statement saying it expects to report a profit of about $2.30 (Canadian) a share for the quarter ended July 31, compared with $1.86 a year earlier.

The bank expects to take an on-paper hit of about $290-million (Canadian) as a result of its investments tied to the U.S. mortgage market. The impact will be $190-million, after tax, the bank said, which translates to about 56 cents a share.

CIBC said its total exposure to the U.S. residential mortgage market before write-downs is about $1.7-billion (U.S.). It estimates that less than 60 per cent of the exposure relates to underlying subprime mortgages

The bank's shares opened up more than 4.5 per cent on the Toronto Stock Exchange on Monday, gaining $3.99 a share to $91.50. The share are more than $16 below their 52-week high.

People familiar with CIBC's thinking said the bank felt that given the recent ructions in global stock markets, it would be “appropriate” to provide investors with “further context” about its third-quarter performance.

They indicated the bank was concerned that equity analysts' forecasts were coming in substantially below what will actually be the case, citing estimates of $1.75 a share to $1.95. The rationale inside the bank is that as a public company it had an obligation to provide guidance if earnings are going to be “well above or below what the marketplace expects,” one person said.

The results will include good revenue, expense and loan loss performance in most business groups, as well as higher than normal gains on securities and credit derivative hedges, and reversals of litigation and income tax accruals, the bank said.

It added that the majority of its $1.7-billion (U.S.) exposure continues to be rated AAA, which is the highest rating category for these types of investments.

“With the exception of our structured credit business we are pleased with our performance in the third quarter,” stated CEO Gerry McCaughey. “We had positive financial results in many areas which more than offset the structured credit write-downs.”

Bay Street applauded the bank's revelations.

RBC Capital Markets analyst AndrĂ©-Philippe Hardy said in a note to clients Monday morning that CIBC's announcement is positive, in his view, “in spite of the exposure to U.S. real estate being larger than we had believed.”

Since May 22, which is the day before the first big Canadian bank released its second-quarter results, CIBC's stock is down 17 per cent, he noted. That compares to a median decline of 10 per cent for the other big banks.

“The relative underperformance of 7 per cent, which we believe is mostly due to exposure to U.S. sup-prime real estate, represents about $2.3 billion in market capitalization,” Mr. Hardy noted.

He said the bank's expected earnings of $2.30 per share are well ahead of his estimate of $1.90 per share, even though the write-down on real estate exposures is much higher than his estimate of $50-million to $100-million.

He is maintaining his outperform rating on the bank, but cautions that “CIBC, like the other Canadian banks, is more likely to trade on news than fundamentals in the near term, and the stock remains susceptible to concerns over the health of financial markets.”

Another analyst, John Aiken at Dundee Securities Corp. in Toronto, welcomed CIBC's announcement by hiking his rating on its shares to “market outperform” from “market neutral.”

“While the pre-announced write-down and remaining exposure to the subprime market are large in absolute terms, we note that they are well below some of the more dire predictions circulating on the Street,” he said in a note to clients.

Mr. Aiken, who had been forecasting a third-quarter profit of just $1.19 for CIBC, also said he think's the bank's remaining subprime exposure is “quite manageable.

“Although additional write-downs are possible and even likely in future quarters, we note that reducing its net exposure to zero would only result in losses of just over $2 per share.”

At investment dealer BMO Nesbitt Burns, analyst Ian de Verteuil, who already had an “outperform” rating on CIBC's shares, told clients in a note that he expects the stock will now climb $5 to $10 in the short term, with $3 to $5 coming from higher profit expectations and $3 to $5 from the higher price-earnings multiple that will be applied.

“We also expect the [entire] Canadian bank group to rally this morning,” Mr. de Verteuil said.